Why maximising information ratios is incorrect

Abstract

Many papers on active management argue for maximizing information ratios using a risk- budgeting framework. Recent innovations in risk-adjusted performance measures show why maximizing information ratios could be the wrong policy and also provide a different twist to the discussion on separating alphas from betas. The literature on maximizing information ratios focuses only on the active management process and ignores two actions used by clients or managers to improve risk-adjusted performance: passive management and leverage/deleverage using cash. This paper demonstrates the impact of maximizing the wrong objective function and shows the benefit of maximizing risk-adjusted returns for the entire fund, rather than the information ratio on the active component.